PRC Corporate Issues inIT Industry

July 2015

Frank Niu, Partner of Beijing Office

Table of Contents

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1. Chinese IT Industry Background

2. Overview: Foreign IT companies doing business in China

3. Investment Structure

4. Market Access Approval

5. Registered Capital and Contribution

6. Cyber Security

7. Tax

8. China's New Foreign Investment Law

9. Pitfalls and Tips

10.Dentons in China

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• Chinese Software Service Industry Revenue Trend 2008-2012

Billion RMB %

Source: National Bureau of Statistics of the People's Republic of China

Chinese IT Industry Background

Chinese IT Industry Background

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• Performance of IT Industry in 2014

Products or Services Revenue(billion USD)Growth rate (%)

Software Business Gross Revenue 620.85  20.2 

 

1 、 Software product188.73 17.6 

     2 、 Information system integration services

128.00 18.2 

     3 、 IT consulting services 64.01 22.5 

     4 、 Data processing and storage service 113.90 22.1 

     5 、 Embedded system software 107.55 24.3 

     6 、 Integrated circuit design 18.32 18.6 

Source: National Bureau of Statistics of the People's Republic of China

Chinese IT Industry Background

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Top 4 Chinese Players

Rank Company Revenue 2014(million USD)

1 Huawei Technologies Co Ltd 20271.17

2 ZTE Corporation 7713.33

3 Haier Group 6687.5

4 Founder Group 2033.50

Chinese IT Industry Background

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The growth of the revenue is slow and staple

The new IT services is getting more popular

The export of software continues to be sluggish

The Middle West China IT markets become increasingly active

IT revenue from main cities keep growing rapidly

Main Trends in Chinese IT industry

Foreign IT companies doing business in China

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Cross-border trade

-Equipment sales

-Technology license

Investment

1. Greenfield investment

- Establish Foreign Investment Enterprises(FIEs)

(1)WOFE

(2) Joint Venture

-Establish a representative office(RO)

- Foreign Invested Partnership

2.M&A

Equity Joint Venture

Cooperative Joint Venture

Investment Structure

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1.Representative Office (RO)

A liaison office of its parent company / no legal person status.

Limited business scope:

- may only engage in a limited number of activities (data collection, market research, technical support, R&D).

- Subject to limited exceptions (law, accounting and consulting firms), an RO may NOT engage in profit-making activities, receive revenue for services, or sign contracts.

2.Wholly Foreign Owned Enterprise (WFOE)

Preferred business vehicle for foreign investors.

-Limited liability company wholly owned by one or more foreign investors

-Flexible corporate governance, pays tax in China and can repatriate profits to investor's home country

3.Equity Joint Venture

A limited liability company formed between one or more Chinese parties and one or more foreign parties.

Profits and losses are based on the ratio of each party's respective equity interests/capital contributions (cash, technology, property, etc.).

Relatively inflexible management structure

Falling out of favor with MNCs.

4.Partnership

Commonly used by VC and PE investors

Ordinary partnership

Limited partnership

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5.Offshore holding company

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Choice of the incorporate site - Hongkong

- Switzerland

Mode of operation: -Technology license

Profit: -Royalty

Benefits: -TAX

-Management efficency-Better protection for IP

Offshore

OnshoreTechnology license

Royalty

Holding Co.

PRC Co.

Parent Co.

100%

IP Co.

Market Access Approval

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1.Foreign Investment Industrial Guidance Catalogue

(effective on April 10, 2015)• Categories: “encouraged”, “restricted”, “prohibited”, or “permitted”

• “Encouraged” and “Permitted” : a foreign investor generally may set up a WFOE. An exemption from import tariffs for equipment for “encouraged” projects.

• “Restricted” : generally open only to joint ventures, and in some cases the joint ventures must be majority Chinese owned or contributed.

• Enterprises engaging in manufacture of IT equipment and the software development belong to the "Encouraged Catalogue"

2. NDRC Approval

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• General

• All other projects only require filing with local NDRC. Provincial governments enact implementing rules.

Approval Authority Projects

NDRC Encouraged sectors + total investment amount ≥ USD 300 million + requiring Chinese majority

Restricted sectors (other than real estate) + total investment amount ≥ USD 50 million

Provincial Government (no delegation to lower level)

Real estate projects Restricted sectors (other than real estate) + total investment amount

< USD 50 million

Local Government (provincial governments decide at which level )

Encouraged sectors + total investment amount < 300 million + requiring Chinese majority

3. MOFCOM Approval

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• MOFCOM Approval of FIEs

Approval Authority FIE

MOFCOM Encouraged sectors + total investment amount ≥ USD 300 million

Restricted sectors + total investment amount ≥ USD 50 million

Local MOFCOM (local MOFCOM could delegate the approval authority to lower MOFCOM)

Encouraged sectors + total investment amount < 300 million

Restricted sectors + total investment amount < USD 50 million

Registered Capital and Contribution

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1. What does registered capital mean?

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Equity contribution by shareholders, may be increased, but generally cannot be reduced

Greater flexibility and autonomy in capitalizing a company

Forms of capital contributions: cash, intellectual property right, land use right, or other non-monetary properties that may be assessable and transferrable

Removal of the requirement for cash contribution , benefits companies in high-tech, entertainment, and modern service businesses.

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2.Technology is qualified as the capital contribution

Technology may be contributed as the registered capital

Technology license is often part of the joint venture arrangement

The value of the technology as capital contributions shall be assessed and verified

No limit for the ratio of the technology contribution

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3. Proportion of Registered Capital to Total Amount

Total Amount of Investment(million USD)

Registered Capital/Total Amount of Investment

<3 >7/10

3-4.2 2.1*

4.2-10 >1/2

10-12.5 5*

12.5 -30 >2/5

30-36 12*

>36 >1/3

*represents the minimum requirement of the Registered Capital(million USD))

Cyber Security

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1. Obligations of Network Operators

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Requirement for Network products and services

-No malicious programs

-Prior consent from users if the network product need their information;

-prompt notice of any security flaws and leaks

Tiered network security protection system

-Formulate internal security management systems and operating rules

-Prevent computer viruses and network attacks

-Record and track the status of network operations and preserve network logs

-Data classification, back-up of important data, and encryption

Provide necessary technological support and assistance for the needs of national security and criminal investigation

2. Protection for the network information security

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Network operators shall establish and complete user information protection systems,

Obtaining the consent of the person whose data is gathered.

Keep users' personal information strictly confidential and must not disclose, sell distort or damage them.

Real identity system

Manage the information published by users

3. Monitoring, Early Warnings, and Emergency Response

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The State establishes network security monitoring and early warning and information bulletin systems and mechanisms for network security emergency response efforts.

Government can take temporary measures regarding network communications in certain regions, such as shutting down internet access in emergency situations.

Tax

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Enterprise Income Tax

-For a new established IT software company, the income from the first and second fiscal year will be exempted from enterprise income tax and for the income earned from the third to fifth year, the enterprise income tax will be reduced by 50%.

-Royalties received by a foreign company from China are subject to withholding income tax at 10%, which may be reduced by tax treaties.

-Foreign companies with at least one permanent establishment in China, the royalty fee should be included in the enterprise income, which shall be taxed at the rate of 25%.

China's New Foreign Investment Law

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China's new Foreign Investment Law

Still under drafting, but could be enacted soon.

The case-by-case approval of foreign investments will be completely

abolished, and replaced by a foreign investment reporting and

disclosure system.

Foreign investments will be generally accorded national treatment

unless they fall under a "negative list".

Represents further liberalization of governmental control of foreign

investments in line with international best practices.

Pitfalls and Tips

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Pitfalls and Tips

1. Know the rules

• China is moving to a rule-based economy, and more disciplined and

transparent market. Foreign investors are expected to follow the rules

more than local players.

• The rules may be complicated in many areas and opaque in some,

leaving local authorities and officials to adopt interpretations and

practices that vary from location to location.

• Be careful with the "hidden rules" or "connections" that may expose

foreign investors to great compliance risks and costs.

Pitfalls and Tips (continued)

2. Know your local partners

• Avoid dealing with dubious partners at the beginning of a relationship.

Subsequent solutions, including legal remedies, may be difficult or

come with high costs.

• Use all means available to perform KYC: public information, market

consultants, trade associations, law firms, industry insiders, etc.

• Different types of Chinese entities may have different motives or

concerns in similar transactions, e.g. state-owned enterprises (SOEs)

must act in line with government policy and strategies, and private

enterprises may be more profit oriented but tend to ignore legal risks.

Pitfalls and Tips (continued)

3. Deal with government authorities and officials properly

• Despite the decrease in approval requirements for foreign investments

in general, foreign investors in highly regulated areas (such as energy

and agriculture) must still obtain a range of regulatory approvals.

• Follow the procedures correctly, enlist assistance from professional

advisors and service providers, and keep good track of written

communications with governmental authorities.

• Meet with officials in charge face-to-face and make your case in a

clear and consistent manner.

Pitfalls and Tips (continued)

4. Transaction structure is key to success.

• Foreign investors should properly structure their investments into

China so as to minimize risks, obtain tax efficiency and other benefits,

and most importantly, have the ability to exit the investments when

things go wrong.

• Use offshore holding companies or other vehicles, but note the tax

implications in both China and home jurisdictions.

• Maximize legal protections in transaction agreements, such as rights

of first refusal, call and put options, deadlock solutions, and appraisal

rights. These concepts are largely recognized by Chinese law.

Pitfalls and Tips (continued)

5. Prepare for the worst: disputes in China.

• Litigation is generally not a preferred solution - It is never easy to

litigate in Chinese courts, and enforcement of foreign court judgments

in China is even more difficult.

• Arbitration is generally a favored form of dispute resolution in

contracts with Chinese partners and customers. It is fast, flexible,

more predicable and commercially oriented.

• The most commonly chosen arbitration institutions and venues include

China's CIETAC, ICC, Hong Kong, Singapore, Stockholm and

London.

About Us

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• With the total value of foreign investment in China increasing each year, the China market offers a wide range of opportunities for foreign investors. Clients seeking to unlock those opportunities require the right kind of legal advisor.

• Dentons is active in foreign direct investment in China, representing foreign investors, private equity and venture capital firms, angel and institutional investors, and overseas businesses in handling M&A transactional work and in all aspects of setting up a business presence in China.

• We regularly act on behalf of international corporations, rendering strategic advisory services in connection with their expansions in China. Our work includes advising on, and structuring, foreign direct investments, including setting up complex onshore and offshore structures; setting up wholly foreign owned enterprises, joint ventures, representative offices, manufacturing plants, wholesale and/or retail shops; acquiring companies in China; and attending to all forms of governmental and regulatory issues.

Dentons in China

Areas of focus

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• Foreign Direct Investments In China

• Corporate Finance/Commercial and Equity and Debt Raising Exercises/IPO

• Investment Funds, Private Equity and Structured Finance

• Retail and Brands in China

• Mergers and Acquisitions

• IP and Related Issues

• Litigation, Mediation and Arbitration

• Employment

• US Corporate Governance and Compliance

• Real Estate Practice

Questions?

3619 April 2023